WASHINGTON, DC – Today, Congressman Jim Himes (CT-04) led a letter signed by eight other members of Congress to Securities and Exchange Commission Chair Mary Jo White and Financial Industry Regulatory Authority Chairman Richard Ketchum raising questions about gross spreads paid by young companies to financial institutions for underwriting IPOs. In the United States, gross spreads for small- and moderate-sized IPOs between $25 million and $250 million undertaken by emerging entrepreneurial companies cluster around 7%.
“All of the signatories of this letter supported the JOBS Act, which tried to reduce compliance costs for businesses by $1-2 million annually,” said Himes. “The difference in a few percentage points in a gross spread for an IPO can be significantly more than that and could make the difference between success and bankruptcy, so we believe it’s worthwhile to take a closer look at this clustering.”
Himes’ letter is based partially on a paper titled “Why don’t issuers demand European Fees for IPOs?” written by a team at Oxford who compared gross spreads in the US and international markets.
“The fact that in our study virtually all small to midsize IPOs in the US pay exactly 7% in fees to the investment banks, while fees for European companies were about one-half of this level, with no clustering at any particular point, deserves careful scrutiny,” said Professors Tim Jenkinson and Howard Jones, two of the paper’s authors, reacting to Himes’ letter. “Reducing the cost of going public would clearly be good for growing companies seeking equity financing, and more generally for US capital markets.”
The other Members signing the letter were Representatives Carolyn Maloney (NY-12), Nydia Velazquez (NY-07), Gregory W. Meeks (NY-05), Stephen Lynch (MA-08), David Scott (GA-13), Emmanuel Cleaver (MO-05), Keith Ellison (MN-05) and John Carney (DE-At Large).
The full letter is below.
July 15, 2016
The Honorable Mary Jo White The Honorable Richard G. Ketchum
Chair, Securities and Exchange Commission Chairman, FINRA
100 F Street NE 1735 K Street NW
Washington, DC 20549 Washington, DC 20006
Dear Chair White and Chairman Ketchum,
We write to you as supporters of the Jumpstart Our Business Startups Act (“JOBS Act”), which was designed to lift some of the regulatory burdens and expenses faced by young companies electing to undergo an Initial Public Offering (“IPO”). During consideration of the JOBS Act, compliance associated with becoming a public company was estimated to cost an emerging company between $1-3 million per year. Reducing that cost at a time of capital scarcity was a worthwhile endeavor.
We ask for your consideration and examination of a cost that may, in many cases, exceed the aforementioned cost of compliance, namely, the gross spread paid by companies to financial institutions for underwriting an IPO. The gross spread reflects the difference between the price at which the underwriters buy shares from the company and the price at which the underwriters sell the shares to the public.
In the United States, gross spreads for small- and moderate-sized IPOs between $25 million and $250 million undertaken by emerging entrepreneurial companies cluster around 7%. By contrast, fees for European IPOs, where offering mechanics are somewhat different from those in the U.S., are considerably cheaper and much more variable; ranging from 1-7% and averaging 4%[1].
The remarkable consistency of IPO pricing in the U.S. has been the subject of scrutiny before, including an investigation by the Department of Justice and a class-action antitrust lawsuit settled in 2007. Nevertheless, U.S. IPO gross spreads are today even more concentrated at the 7% mark than they were in the past, and convergence of IPO methodologies makes comparisons between U.S. IPOs and non-U.S. IPOs more meaningful.
We are concerned that a 7% gross spread represents a significant capital cost to young companies. The median IPO in the U.S. is approximately $100 million in size. The average $7 million gross spread, which does not include legal and accounting fees or other expenses, is a sizable amount relative to the purported cost of initial and ongoing compliance. One study estimates that if U.S. IPOs were accomplished at European gross spread levels, entrepreneurial U.S. companies could save over $1 billion per year.
We are justifiably proud and supportive of U.S. capital markets and their ability to finance innovative new startups into world-beating companies. It is hard to explain the dramatically different pricing of U.S. and non-U.S. IPOs, so we believe more thorough analysis is required. We therefore request that FINRA and the SEC undertake a study of this issue and, if appropriate, consider remedies to ensure the health of our capital markets and start-up ecosystem.
[1] M. Abrahamson, T. Jenkinson and H. Jones, “Why don’t issuers demand European Fees for IPOs?” 2011, 66 Journal of Finance 2055.